Be Mindful of the Herd

SAN FRANCISCO -- Perhaps the most amazing aspect of Wednesday's session was how quickly the sentiment swung from giddy to gloomy. Abrupt psychology shifts are nothing new on Wall Street, and that's a big reason there are few teetotalers on trading desks. Just last week for example, the pendulum went from terror on Monday to delight heading into Friday's session, with neither extreme proving justified. (Space considerations prohibited delving further into this issue Wednesday night, but I wanted to venture forth here.)

Rapid market swings are often blamed on fairly recent, dramatic improvements in trading technology and the rapid dissemination of information in the digital age. While certainly contributing to the trend, those factors only seem to exacerbate what market observers have long known: Investors tend to move in herds, a big reason there are few true or obvious social misfits on trading desks (and until relatively recently, traders have been primarily men).

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Since Jan. 3, the Wall Street playbook has been turned to a page detailing a belief that "The first half [of 2001] is going to be weak, but the Fed is on our side so we can buy techs because they're washed out," according to Scott Bleier, chief strategist at Prime Charter. "The new given is 'this isn't a recession but an inventory correction,' so you can buy -- not Intel (INTC), Cisco (CSCO) or Microsoft (MSFT), but almost everything else."

Such views -- along with the so-called January effect -- are a big reason stocks such as Allegiance Telecom (ALGX), Xcelera (XLA) and SeeBeyond Technology (SBYN) (among many others) enjoyed huge percentage gains in recent weeks after struggling in 2000.

On a separate but related note, the market seems to have rapidly gone through the food chain that historically develops in the wake of a new Fed easing cycle. Since "everybody" knows what's going to happen, the cycle gets accelerated; sort of like how the "January effect" has been spotted in October and November in recent years.

Bear Stearns equity strategist Elizabeth Mackay observed the phenomenon in a report issued Tuesday. "It has only been a short period of time [but] group performance since the Fed's bold stroke seems to be following the script," she wrote, noting outperformance by technology, "consumer discretionary and other soft cyclical" stocks, and relative weakness in energy, utilities and other defensive groups.

Mackay didn't seem perturbed by the trend, but one fund manager generally disposed to favoring growth stocks was.

Insurance stocks such as AIG (AIG) and Chubb (CB), as well as financials like Fannie Mae (FNM) and Washington Mutual (WAMU) were decimated last week "on nothing other than sector rotation," the fund manager fretted. "These markets are ridiculous. We are now looking at utilities and drugs, given the selloff in the past two weeks."

It was as if the entire investing community said (collectively): OK, rate-sensitive, basic materials and defensive names did well in anticipation of the Fed rate cut. Now that it's arrived, let's move on to growth issues. Remember, past performance is no guarantee of future returns. While history has shown the wisdom of such strategies, it all seems a little too pat this time, doesn't it? If the economy isn't going into recession, maybe the Fed isn't going to have to ease so much or so aggressively. And if the economy is heading for bigger trouble, do you really want to be in stocks with (still) historically high valuations?

The answers to those questions aside, Bleier believes this period where "psychology is swinging the market hour by hour" is going to end soon, leaving those compelled to play the momentum game once again in a world of hurt.

"We had a nice January bounce and people are getting really excited -- but you've got to lighten up and take profits near term," he said. "Everyone thinks stocks at $3 are going to $5 -- therefore, we must pull back near term and bag them. We must, must, must." Perhaps Wednesday was a forecast.

Unintentionally (I think), the strategist laid out a similar view detailed here recently by Sam Ginzburg at Gruntal: That the market is likely to settle into a trading range, and participants looking for big up or down moves will be disappointed.

The strategist also unwittingly expressed an outlook shared by Ginzburg and James Cramer: That it will be the long-term investor buying "quality companies" who will reap the biggest profits going forward. "The market is going to work off all the trader mentality. Near-term trading is going to become very difficult" for all but the most seasoned pros (and even they will often find a little too much paprika, or not enough coriander).

"You can't chase stocks," he declared. "Don't play the momentum game."

The Message and the Medium

My point in all this is not to scare anyone out of the market or to wish stocks lower. Rather, it's to help those who hear the gurus saying "the Fed has eased, buy now" avoid the temptation to get panicked into buying first and asking questions later. The point is, you do have time to ask those questions, and to do the homework. It's likely most stocks you fret are running away from you now will not be like Shane, meaning, you won't have to plead for them to come back.

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